Corporate Governance

The implementation of a set of behavioural rules usually arises out of some form of crisis or misdemeanor.  So it was that the Combined Code grew out of reports commissioned following scandals such as Guinness and Polly Peck which rocked the City in the late 80s and early 90s.  Its purpose “is to promote good governance in the belief that this will support the long-term success of the company”.

It is therefore no surprise that the most recent review of the Code by the Financial Reporting Council, previously scheduled for 2010, was brought forward as a result of the meltdown in the financial world.  It is now in its consultation period until 5 March 2010 and is likely to apply to accounting periods subsequent to 28 June next year.

The review of the Code, to be renamed “The UK Corporate Governance Code” to make its raison d’être clear to all, was conducted in close co-operation with Sir David Walker who was commissioned by the Government to review governance of financial institutions in the wake of the crisis.  Indeed, the changes proposed by the FRC broadly reflect those proposed under Walker.  Unlike the Walker review though, the Code is non-sector specific and does not include some of the politically motivated, headline-grabbing recommendations such as disclosure of high earners’ remuneration. 

All listed companies will need to monitor the consultation process closely as to the likely changes to the Code’s Main Principles, given the requirement on them to “comply or explain”.  Proposed new additions to those Main Principles include:

• the chairman being responsible for leadership of the Board and for ensuring its effectiveness;
• a “fit for purpose” obligation on the composition of boards to enable them to discharge duties and responsibilities effectively;
• an obligation on non-executive directors to constructively challenge and help develop proposals on strategy; and
• directors being required to allocate sufficient time to perform their responsibilities effectively.

Quite apart from the comply or explain rule, added strength is given to these principles by what is clearly the favoured media sound bite applied to the publishing of the FRC’s report – “annual re election”.  It remains to be seen whether that will ultimately apply to just the chairman or to the whole board, be annual or some longer period or be triggered by some shareholder dissatisfaction (Walker recommends that if 75% of shareholders disagree with the remuneration report, the chairman of that committee must be put up for re-election).

There is a move away from what has been an over-emphasis on independence at the expense of seeking the appropriate balance of skills, experience, independence and knowledge.

The importance of commitment is emphasised in the FRC’s report and this is the main driver for the requirement on directors to allocate sufficient time to their duties.  It picks up on the proposal of Walker to impose minimum time requirements, recognizes that this is too specific for the broad spectrum of companies covered by the Code but embraces the “spirit of Sir David’s recommendation” using the general principle.

The FRC state very clearly that they are aiming to redress the balance of the Code to put an emphasis on behaviour rather than process.  It is acknowledged that companies have been focusing on the latter, leading to the erosion of one of the practical cornerstones of the style of the Code – less prescription, more spirit and an ability to react to best practice.

The FRC and Walker recommendations provide a timely reminder of the need for best practice in corporate governance in the UK.